1. Since the beginning of 1994, the government has been implementing a bold program to
restore
macroeconomic stability and support a rapid transition towards a market economy. The
reform
strategy has been designed around the discipline of a fixed exchange rate coupled with
structural
reforms to create market institutions, consolidate private ownership, and reduce the cost of
doing
business. Financial support from the International Monetary Fund, the World Bank, the
European
Union, and other bilateral donors has been key to the successful implementation of the
program.
An adverse regional environment notwithstanding, the post-independence decline in output
has
been arrested, price stability has been restored, relations with all external creditors have
been
normalized, and an extensive structural reform agenda has been implemented.

2. To enhance the conditions for growth and a sustainable reduction in unemployment, the
government intends to continue pursuing the medium-term strategy outlined in the original
Policy Framework Paper for the period 1997–99. Together with the staffs of the IMF
and
the World Bank, a revised program for 1998–2000 has been developed (summarized
in
Table 1) for which the government is seeking continued
support in the form of a second annual
arrangement under the IMF’s Enhanced Structural Adjustment facility (ESAF) and a
Social Sector Adjustment Credit (SSAC) from the World Bank, in addition to other ongoing
adjustment and investment lending.

3. The adjustment strategy in 1997 relied on a tightening of the fiscal stance to support a
reduction in the current account deficit without a change in the nominal exchange rate. With
cost
competitiveness having improved steadily since 1995 as a result of price stability and
restructuring in the enterprise sector, export growth was expected to contribute significantly
to
external adjustment and to lead a recovery in output from its depressed level. Meanwhile,
structural reforms were advanced on a broad front: the privatization program was kept up;
measures to restructure the largest commercial bank were implemented; the labor laws were
amended; laws to streamline bankruptcy proceedings and the execution of claims were
introduced; a restructuring program was begun in the agricultural sector; the external trade
regime was liberalized further; and changes were made to social benefits in order to
improve
the
sustainability of the social safety net and its targeting to the most needy.

4. However, while broad price stability was maintained, real GDP growth of 1.5 percent in
1997
fell short of the 5 percent target. Part of the growth shortfall reflected a competitiveness
problem
that was revealed in the first half of the year when the balance of payments remained under
strain
despite evidence that the economy was stagnating. Thus the denar, which had maintained its
parity against the deutsche mark since early 1994, was devalued by 14 percent in July. The
devaluation was supported by a wage freeze in order to ensure the maximum boost to
competitiveness. Strong fiscal backing was also provided through supplementary
expenditure
cuts and measures to strengthen tax compliance, although the original fiscal targets proved
unobtainable due to a large revenue decline in the first half of the year. Since the
devaluation,
price stability has been maintained, the foreign exchange reserves have increased, and
exports
and output have begun to recover.

5. The disappointing growth performance in 1997 also reflected the continuing problems in
the
enterprise and banking sectors. With privatization well advanced, low profitability and
rising
inter-enterprise and wage arrears were to a large extent the result of poor corporate
governance
and insufficient enterprise restructuring. At the same time, the recycling of bank credit to
loss-makers perpetuated very high real interest rates (around 20 percent), starved profitable
enterprises of working capital, and added to the fragility of the banking system. The
government
places priority on addressing these problems in its updated economic strategy.

6. The government’s strategy for 1998–2000 aims to improve living standards
by
consolidating private ownership and strengthening market-based institutions.
Macroeconomic
policies will focus on providing a stable financial environment to engender enterprise
adjustment, reduce interest rates, and promote investment and jobs. The structural policy
agenda
will focus on measures to strengthen corporate governance and bank lending practices,
while
a
radical overhaul of the size and structure of public expenditure will place the fiscal accounts
on a
more sustainable footing and provide room for a reduction in the excessive direct tax
burden.
Emphasis will also be placed on developing financial markets in order to foster savings and
enhance monetary control, on removing barriers to trade and foreign investment in order to
promote the transfer of needed capital and technology, and on removing labor market
restrictions.

7. GDP growth is projected to average 5 percent a year in 1998–2000 (Table 2). In 1998,
growth mainly results from an increase in exports as a result of the devaluation. Thereafter,
productivity-enhancing structural reforms and lower interest rates are expected to foster
continuing strong export growth and an increase in investment to 20 percent of GDP in
2000
from 17 percent of GDP in 1997. Financial policies will ensure that annual inflation is at or
below 3 percent, while official reserves are projected to increase to three months of
merchandise
imports by end-2000.

8. Strong import demand driven by the expected recovery in economic growth and high debt
service payments to official and commercial creditors will continue to place demands on the
external balance of payments. Assuming a stable regional situation, higher export earnings
will
provide part of the needed financing, while anticipated direct investment receipts will
contribute
further resources. Nonetheless, additional resources from the international community will
be
needed to ensure that the balance of payments is fully financed.

B. Fiscal Policy and Budget
Reforms

9. The key objective is to bring the structure of taxes and expenditures in line with the
country’s development needs. This will require a radical overhaul of expenditures
involving reductions in public sector employment, the elimination of inefficiencies in the
health
and education sectors, and reforms to social benefit programs to ensure their long-term
affordability. At the same time, the tax system will be modernized and direct tax rates
lowered in
order to reduce disincentives for job creation. At all times, a prudent fiscal stance will be
observed with any deficits being matched by external financing of capital expenditures.

Taxation Policies

10. In view of an unexpected collapse of revenues in the first half of the year, tax policy in
1997
focused on measures to enhance tax compliance. These had two main components: a
one-time
tax amnesty and the use of the Bureau of Payments Operations (BPO) to automatically
deduct
social security contributions from enterprises’ accounts. The measures have so far
proved
successful. In addition, excise taxes on cigarettes, which had been so high as to encourage
tax
evasion, were cut sharply, the corporate profit tax rate was halved to 15 percent, and the
profit
tax surcharge earmarked for the Public Water Management Authority was revoked. The
customs
administration has been brought under the purview of the Ministry of Finance and, with
technical
support from the IMF and World Bank, is well advanced in implementing the ASYCUDA
electronic data management system. There was no room to begin lowering social security
contribution rates in the 1998 budget. However, in a move to encourage job creation, the
government introduced a limited scheme to exempt new employees from social security
contributions.

11. A key element of the government’s tax reform agenda is the replacement of the
sales
tax by a broad-based VAT. The Ministry of Finance has established a VAT developmental
unit
and is in the process of developing the necessary regulations and training tax administration
staff.
The government will submit final VAT legislation to parliament by mid-1998 with a view to
full
implementation at the beginning of 1999. Technical assistance from the IMF and bilateral
donors
has been arranged in this regard.

12. Additional reforms will focus on: rationalizing personal income tax exemptions;
replacing
various corporate tax preferences, including those for foreign investors, by a single
investment
expenditure allowance; introducing a profits tax carry-over provision; replacing the taxation
of
bank lending spreads by a VAT on financial services; and, over time, establishing an
effective
global income tax. The elements of the BPO responsible for withholding personal income
and
social security taxes will be merged with the tax administration department into a new
Central
Treasury Office, which will be provided additional resources to broaden the coverage of the
growing private sector. In order to generate resources for budgetary priorities, special
revenue
items—including earmarked taxes (such as stamp duties) and administered fees (such
as
passport fees and legal penalties)—will be transferred to the general account in the
1999
budget.

13. These tax reforms, combined with a rationalization of public sector expenditure, should
allow
the government to reduce tax and social security contribution rates, beginning in the 1999
budget.
Combined with projected macroeconomic developments, these reductions should allow
government revenue to fall from 38.9 percent of GDP in 1997 to 35.5 percent of GDP in
2002.

Expenditure Policies

14. While export and agricultural subsidies have been largely eliminated and the public
sector
wage freeze extended into 1998, broader public expenditure reforms in 1997 were
overshadowed
by the need to re-balance expenditures with the lower-than-budgeted revenues. Maintaining
fiscal
balance came at the expense of discretionary expenditures, particularly investment
programs,
which will need to be restored. Recognizing the need to reduce the size and cost of the
public
sector, the government received technical assistance from the IMF in 1997 on options for
restructuring public expenditures.

15. The current level of public expenditure is more commonly seen in countries with much
higher per capita incomes. A correspondingly high level of non-discretionary spending,
especially on wages, constrains budget policy and the ability to push through needed tax
cuts.
Building on recent technical assistance from the IMF, the government intends in 1998 to
prepare
a comprehensive public expenditure plan. The reform plan for the central government will
address the structure of line ministries, the level of budget sector employment, and the
public
sector salary structure. Rationalization of the education sector will not be done in a way to
undermine the quality of education. Nor is it the expectation that cuts in public employment
would translate one-for-one into higher unemployment as the focus will be on spinning off
publicly-provided services into the private sector. At other levels of government, the
government
will introduce measures to rationalize the health sector and social security benefits (see
Section
IV). Our ongoing reform plans for public expenditure will be developed with the support of
the
World Bank through an expenditure management study and, subsequently, a public sector
adjustment lending operation.

16. The government recognizes the need to start servicing frozen foreign currency deposits
in
order to foster confidence in the banking system. It plans to do this by issuing tradable
securities
in exchange for the deposits, a move which should help to develop financial markets. The
government will keep cash repayments low over the next few years to avoid undermining
the
fiscal and balance of payments position. To help reduce the need for cash repayments, the
government will investigate ways to exchange frozen foreign currency deposits for
government
assets such as land and privatization shares.

17. Control over the planning and execution of the budget will be enhanced in a number of
ways.
First, the Ministry of Finance will allocate more resources to improve budget analysis and
forecasting as a first step toward developing a system of program budgeting. Second, a
Central
Treasury Office, separate from the Budget Department and incorporating all treasury
functions
currently performed by BPO will be established during 1998–99. Third, computerized
reporting of commitments will be extended to line ministries by end-1998. Fourth,
integration
into the budget of the various extra-budgetary funds—including the Bank
Rehabilitation
Agency, the Road Fund, the Privatization Agency, and counterpart funds of foreign
assistance—will be reviewed so as to improve overall financial control. Fifth, an
integrated
Management Information System for health facilities and the Health Insurance Fund,
supported
under the World Bank Health Sector Project, will be developed. Given successful
implementation of the government’s reforms, expenditure is projected to decline
from
39.4 percent of GDP in 1997 to 35.5 percent of GDP in 2002.

Public Investment Program

18. The government’s investment program emphasizes economically viable projects
consistent with the need to maintain macroeconomic stability in the medium term.
Implementation of the Public Investment Program (PIP) in 1997 slipped, given the severe
fiscal
constraints, and general government investment was only 1.5 percent of GDP. Projects
expected
to have been started/completed in 1997 have been rescheduled in the government’s
updated PIP for 1998–2000. This plan identifies 51 projects, of which 38 are new, in
the
areas of water resources, telecommunications, energy, transport, education, environment,
health
and social services. The estimated cost for the general government and public corporations
is
$900 million. The government intends to finance about 19 percent of the cost of the projects
in
the PIP out of its own resources. A further 64 percent of the financing is expected to be
raised
from external donors and creditors, with the remaining 17 percent being raised from
domestic
private sources. The government will selectively implement projects identified in the PIP
depending on the availability of appropriate financing. The Ministry of Development will
continue its yearly updates of the PIP and prepare reports on the progress and financing of
PIP
projects. Budgetary resources and guarantees will be provided only for investment programs
included in the PIP. The government will work on building technical capacity to analyze and
improve the quality of the PIP and seek long-term technical assistance for this purpose.

C. Monetary Policy and Financial Market
Development

19. The government does not believe there is a case for moving away from an exchange-rate
based monetary policy at this stage, particularly given the importance of exchange rate
stability in
the formation of inflationary expectations and the difficulty of estimating money demand in
a
small, open economy. Since the devaluation, the strains in the foreign exchange market have
dissipated and monetary growth has recovered. Interest rates remain high, but this largely
reflects
structural problems. While the appropriateness of the exchange rate level will remain under
review, productivity growth and cuts in labor taxes are expected, over time, to enhance
competitiveness and cement the sustainability of the balance of payments.

20. With further technical assistance from the IMF, the National Bank (NBM) is designing a
plan
to eliminate bank-by-bank credit ceilings and to achieve monetary control through more
efficient
indirect instruments. A prerequisite is to deepen the market for NBM bills through
enhancing
their yield and liquidity characteristics, as well as to increase the transparency of deposit
auction
procedures. In order to facilitate development of a secondary market, bills in a paper form
will be
issued. The NBM and Ministry of Finance will also explore issuing treasury bills and the
possibility of introducing repurchase operations with short-term commercial and
government
paper. In conjunction with these plans, the NBM will make a clear distinction between
lending to
banks in distress and lending through its deposit auctions, so as to achieve a more
market-based
allocation of NBM credit. Accordingly, interest rates on the NBM’s Lombard facility
will
be raised to at least the level of overnight interbank interest rates. Pre announced prudential
ceilings will remain the only restrictions on the size of banks' cumulative access to deposit
auctions, and these will not be frequently changed. Liquidity management will focus instead
on
developing the market for bills, which will also allow the elimination of time deposit taking
by
the NBM. The NBM will continue to support development of the inter-bank money market
by
encouraging participation and reducing costs. Reserve requirement ratios for sight and term
deposits will be unified and the rate of remuneration on required reserves raised.

21. Phasing out bank-by-bank credit ceilings will be backed up by enhanced bank
supervision. In
this context the NBM will submit to its Executive Council guidelines for dealing with
failing
financial institutions, ensure adequate staffing for off-site supervision, develop a basic
training
program for supervisors, increase the number and frequency of on-site inspections, and
introduce
tougher accounting standards and audit requirements for banks. In the same vein, the deposit
insurance scheme will be modified to lower the potential for moral hazard by imposing a
specific
denar cap on amounts insured and clarifying that the fund will make payments to depositors
of
insolvent—and not illiquid—banks.

D. Banking Sector and Payments System
Reform

22. A large stock of non-performing loans that is perpetuated by the recycling of bad loans
to
loss-making enterprises is a major factor keeping interest rates high. To head off potential
systemic problems, and to bring pressure on banks to strengthen their lending practices, the
NBM
has stepped up its monitoring of bank lending to delinquent debtors. Some of the largest
individual bank exposures to bad debtors will be reduced through enforcing prudential
regulations governing single-exposure limits, which came into effect at end-April 1998. In
other
cases, the NBM will carry out on-site inspections of all banks that do not heed advice to
provision new lending to delinquent debtors; in the case of enterprises with debt that is
already
more than 50 percent classified in category D or E, banks will be expected to fully provision
all
new lending. The NBM will complete full audits of the three largest commercial banks
shortly
after the middle of 1998.

23. To further ensure more healthy relations between banks and enterprises, regulations on
exposure to connected parties will be strictly enforced and banks will be required to sell
equity
acquired through debt-equity swaps. Banks will be expected to take the lead under the new
Bankruptcy Law in forcing delinquent enterprises into bankruptcy.

24. NBM credit to the largest commercial bank, Stopanska Banka, has been successfully
restricted, 360 employees of the bank have been laid off, and the large short-term debt of
Stopanska to the NBM has been exchanged for government bonds held by Stopanska. The
expected sale to foreign investors of a majority shareholding in Stopanska potentially
represents
a big step toward more independent, profit-oriented banking. However, mindful of past
slippages
in the timetable for selling the bank, Stopanska’s credit ceiling and its restriction on
access
to NBM liquidity will remain in place until the sale has been completed.

25. The government intends to set up a new export bank. It will not be a deposit-taking
institution and its initial capital will be limited to DM 30 million. The bank will operate on
commercial terms and any development activities will be limited to on-lending lines of
credit
from official foreign agencies. The bank will be barred from doing business with enterprises
that
are not current on their loans to commercial banks.

26. To complement the new Law on Executing Claims, the government will approve a new
law
on movable collateral in 1998. This should strengthen institutions and judicial practices
related to
lending and improve loan recovery rates. The government will also establish a credit bureau
that
will disseminate information and analysis on the financial condition of companies.
Continuing
technical assistance will be sought to improve risk management, credit appraisal, loan
administration, and accounting standards.

27. A move toward a more decentralized payments system that is consistent with supporting
financial sector development is well advanced. Corporations can now submit large value
payment orders though commercial banks as opposed to solely the BPO, and the BPO fee on
interbank transactions through the NBM has been eliminated. Further reforms will focus on
eliminating the restriction on legal entities to have only one payments system account,
gradually
lowering the threshold for large value payment orders that can be intermediated through
commercial banks, and shifting the credit risk in the settlement system from the NBM to
commercial banks. The ultimate goal is to have banks take over complete administration of
all
accounts and fully implement a real time gross settlement system by 2000. Responsibility
for
the
withholding of wage taxes will be shifted during 1998–99 to a Central Treasury
Office
under the Ministry of Finance. Also the BPO’s responsibility to seize assets of
debtors
will
be shifted to commercial banks acting under the guidance and within the jurisdiction of
appropriate bankruptcy courts, once the government has reviewed legislation on the
enforcement
of commercial contracts and implemented measures to improve the efficiency of judicial
procedures.

E. Privatization and Enterprise
Restructuring

28. The privatization of over 1,200 enterprises identified for divestiture has been completed
and
the process for the few remaining enterprises is underway. Nonetheless, enterprise
performance
has yet to turn around, investment is stagnant, and foreign investor interest remains muted.
It
is
true that many of the reforms that have been put in place will take several years to come into
full
flower. Nonetheless, the keys to more effective structural adjustment are to further improve
corporate governance through consolidation of ownership and to allow the new bankruptcy
procedures to operate.

29. The government is taking the lead in addressing the problems in 12 large loss-making
enterprises that either remain in majority public ownership or that will revert to public
ownership
because of non-payment of privatization installments by the current owners. The plan is to
restructure and sell the enterprises to strategic investors by early 1999. Those that cannot be
sold
will be liquidated. To facilitate the government’s plan, an external advisor is being
appointed and the current law on the Privatization of Social Capital has been amended to
eliminate biases toward employee and management buyouts and remove price restrictions
on
the
direct sale of enterprises. The government can potentially offer large packages of shares in
additional enterprises by combining the equity holdings of government agencies such as the
Bank
Rehabilitation Agency and the Pension Fund. Unviable enterprises that cannot be sold will
be
liquidated. Effective privatization will also be enhanced by enforcing the deadline for banks
to
divest shares acquired through debt-equity swaps.

30. The ability of managers to block sales of shares to outsiders remains an important
barrier
to
improving ownership structures despite efforts in 1997 to eliminate restrictions inherent in
the
company law. The government has therefore amended the company law again to address
remaining loopholes and remove restrictions on secondary share trading for all companies.
As a
complementary measure, it will require that registries of shares are not kept by companies
but
are
held independently in the central share registry and a mechanism for trading shares in
book-keeping form be instituted. A one-stop agency to assist foreign investors will also be
set
up
and regulations in the legal code that might deter foreign investors streamlined. The legal
apparatus for enforcing commercial contracts will continue to be reviewed and mechanisms
for
resolving business disputes and enforcing bankruptcies strengthened. To this end, technical
assistance will be required to train and educate judges.

31. To further strengthen financial discipline in the enterprise sector the government will
re-examine the seniority of wage claims over commercial creditors for illiquid firms. The
government will also re-examine the possibility of providing time-limited incentives,
including
tax relief and discount on shares, to convert wage arrears of longer than two months into
equity,
and will continue to adhere to its policy of not taking over obligations for severance
payments by
enterprises or for clearing their wage arrears. Additionally, the government will initiate
bankruptcy proceedings against enterprises which are in arrears on their payments to the tax
authorities and the public utilities.

32. Property rights need further strengthening. To this end, the government intends to
approve
two laws on Land Use which will promote a more efficient market for properties, and
develop
freer and better functioning land markets in both rural and urban areas. Concurrently, a new
law
on restitution and denationalization of property nationalized after 1944, should make it
possible
to transfer state-owned land to the private sector.

F. External Policies

33. International trade will be an important source of medium-term growth and the
government is
committed to further enhancing the openness of the economy and removing distortions in
the
trade regime. To achieve its objectives, the government has concluded a Trade and
Cooperation
Agreement with the European Union as a first step towards an association agreement and
has
signed several bilateral free trade agreements with regional trading partners. Supported by
the
World Bank SAL, the granting of discretionary exemptions by various government
ministries
has
ceased, export subsidies have been eliminated, and reform of the customs administration has
continued. Average tariff levels and tariffs and/or surcharges on items which were
previously
subject to quotas and special levies will continue to be lowered over the medium term. In
1998, a
revised customs code will be enacted, a trade policy unit will be established within a central
economic ministry, and the government will accept the obligations of Article VIII, Sections
2, 3
and 4 of the IMF's Articles of Agreement.

G. Sectoral Policies

Agriculture

34. The agricultural sector will continue to be an important contributor to growth and
employment. Recognizing that market forces are the key for sustainable agricultural growth,
the
government is implementing a series of policies aimed at reducing interventions in input
and
output prices and reorienting its role to support private sector development. Supported by
structural adjustment lending from the World Bank, important parts of this agenda have
been
advanced including elimination of price premia and input subsidies, rationalization of the
operations of the Agency for Strategic Reserves, and privatization and restructuring of
agro-kombinats to improve their profitability and enhance the competitiveness of
agricultural
input and output markets.

35. The government’s efforts will continue to focus on the liberalization of prices and
trade restrictions, reform of land tenure and transfer, and completion of the agreed program
for
privatizing and restructuring agro-kombinats. The level of protection of agricultural
products
will
be reduced further. The World Bank is supporting these efforts in the context of continued
adjustment lending as well as a credit for financing the reorientation of agricultural
extension
and
veterinary services towards private sector operations, and a loan for the rehabilitation of
irrigation works and development of water users’ associations.

Energy

36. The energy sector is still largely government-owned and controlled, with the exception
of
the
main petroleum products distribution company. Most energy prices are administered, though
they
have generally been set at high enough levels to cover costs and provide a reasonable
margin
for
capital replacement. The government is in the process of developing a strategy for the
energy
sector that has at its core a reliance on market mechanisms. It will acknowledge that: (i)
energy
prices should cover operating costs with a margin to fund future investments; (ii) energy
sector
companies should not rely on government financing; (iii) energy sector companies should
operate
as commercial entities and, where appropriate, be privatized; and (iv) energy conservation
should
be encouraged through cost-based pricing of energy and the restructuring of the economy,
which
should lead to reduced energy intensity of production. In line with its objectives, the
government
will prepare plans to privatize the oil refinery and the electricity company and to establish
independent regulatory systems. On the investment side, with support from World Bank
energy
sector project, over 90 percent of the country’s hydro-power capacity will be
rehabilitated,
the energy management system for the electricity company—including controls,
dispatch
center and communications—will be improved, and the rehabilitation of the electricity
distribution system will commence.

Transport and Communications

37. The shift to a market economy is resulting in less emphasis on transport-intensive
industries,
such as minerals, and more on higher value-added light industry, such as agro-industry. The
latter
will require lower transport volumes and greater use of road as opposed to rail transport.
The
government’s strategy is to upgrade the main road links, particularly those serving as
access to ports, which are already showing incipient congestion. This will be supported by
financing from the European Investment Bank. In addition, the government plans to
continue
the
process of railway restructuring through the spin-off of non-core business and downsizing of
the
railway company’s operations. Recognizing that the construction of a railway link to
Bulgaria cannot be justified on economic grounds, the government will review the
availability of
highly concessional financing for this project before deciding whether to proceed further. In
telecommunications, the government is already preparing the privatization of Macedonia
Telecommunications and will complete the sale of 30 to 40 percent of its shares to foreign
strategic investors by 1999.

Environment

38. The government's environmental objectives, as defined in the National Environmental
Action
Plan, are to develop an environmental management system with adequate institutional
capacity
and an appropriate regulatory framework. In the context of the new Environmental
Framework
Law, the government is developing regulations conforming to EU standards covering
environmental impact assessments, air pollution, national parks, noise, solid and industrial
waste,
and protected species. These regulations also seek to improve water supply and surface
water
quality by: upgrading water resource management and eliminating industrial effluent
discharges;
reducing soil pollution, improving agricultural and forest land management; and conserving
and
protecting biodiversity, particularly in lakes Ohrid, Prespa and Dojran. The government also
intends to develop an action plan to phase in the use of unleaded gasoline based on pricing
policies which discourage the consumption of leaded fuel, and national strategies for solid
waste
management, sustainable biodiversity conservation, and energy conservation.

39. River and lake water pollution arising from a lack of treatment of municipal sewage and
discharges from heavy industry are serious concerns as they contribute to the contamination
of
drinking water. To address the problems, the government intends to develop sewage
treatment
plants for Skopje and Bitola—the two largest towns and major polluters of the Vardar
River, which provides water to downstream users—supported in 1999–2000 by a
loan
from the World Bank and feasibility studies provided through EU Phare. The project would
assist
in implementing a commercial approach to the management of water supply and sewerage
services, with full cost recovery of the services. Tariffs for water usage, which are currently
set to
recover operating costs, will be increased to allow the various water management authorities
to
finance capital investments out of their own resources. A project for the protection and
conservation of Lake Ohrid supported by the Global Environment Facility/World Bank will
be
implemented jointly with the government of Albania this year. Feasibility
studies for the upgrading of waste water facilities in the Lake Ohrid region will be carried
out
with assistance from the German government—linked to a possible loan for associated
investments.

H. Improving Macroeconomic
Statistics

40. While the quality and availability of statistical data have improved since independence,
the
government is aware that further efforts are required. To that end, the government is
strengthening the legal framework in order to provide the required legal authority to the
agencies
that collect and compile macroeconomic statistics by adopting an Act on State Statistics.
The
government recognizes the importance, in particular, of improving the compilation of
balance
of
payments statistics and of accelerating work on the regular and timely compilation of
national
accounts on an SNA basis. The government is seeking technical assistance from the IMF
and,
in
the case of national accounts statistics, the World Bank through an IDF grant.

41. Through creating the conditions for rapid economic growth, the government’s
objective is to achieve a lasting reduction in poverty (Table
3). However, the task of poverty
reduction will be made difficult by the persistence of high unemployment, already (by some
measures) over 30 percent, and by the need to ensure the affordability of benefit programs.
The
government remains committed to providing a comprehensive system of health, education,
and
social security benefits. Where reforms are warranted, emphasis will be placed on the
targeting of
benefits to ensure protection of the most vulnerable members of society.

A. Pension System

42. Pension expenditures remain high, particularly given the relatively young population
structure. Initial early retirement policies for laid-off workers combined with a declining
contribution base have exacerbated imbalances in the pension system, despite wholesale
reforms
of recent years, including a lowering of minimum benefits for new retirees at the beginning
of
1997. Simulations indicate that the aging population will lead to a future destabilization in
the
finances of the Pension Fund unless the structure of benefits is changed further. To put the
pension system on a more sustainable basis, the government intends to: (i) continue to
increase
the retirement ages for men and women; (ii) place retirement on an age exclusive basis,
subject to
a minimum number of contribution years; (iii) index benefits below wage growth; and (iv)
reduce the rate for accumulating the pension base used to specify public pension. There will
be
no increases in the contribution rate. World Bank assistance in the context of the SSAC is
being
requested to support these reforms.

43. At the same time, the government is preparing plans—in conjunction with the
World
Bank—to develop and introduce a private pillar of the pension system. The design of
future
private pension schemes will be developed by a steering committee comprising members of
the
Ministry of Finance, the NBM, the National Securities and Exchange Commission, and the
Pension Fund. It will be based on actuarial and financial scenarios. New regulatory bodies
will be
formed to implement the required legislation and regulations related to the tax treatment of
pensions and to the management, administrative, and investment guidelines for pension
funds.

B. Social Assistance

44. The government has been active in improving the adequacy and targeting of the
means-tested
social assistance program for persons capable of work and, with World Bank support, has
improved its poverty monitoring capacity. This program, along with supplemental programs
for
the elderly and disabled, is the main vehicle for protecting the poor. With additional support
in
the context of the SSAC, the government plans to start tackling some of the second
generation
problems confronting the program including reducing the 22 percent rural-urban benefit
differential that, according to recent work on the poverty line, is far greater than is
warranted.
Targeting of benefits also needs to be further strengthened as some ineligible households
continue to participate in the program. The government intends to revise the Social
Assistance
Decree to: (i) equalize rural and urban social assistance levelsin a budget
neutral way, based on a new single national poverty line; (ii) revise and simplify scale rates;
(iii)
remove "exact percentages and rate" from the law; (iv) increase penalties for
fraudulent claims; and (v) introduce work incentives by limiting full benefits to two years
and
reducing benefits over the next two years to 70 percent and 50 percent, respectively. After
four
years, individuals would re-qualify only after two years of non-receipt of benefits.

C. Labor Market Policies and
Unemployment Benefits

45. The low demand for workers in the formal sector can be attributed in part to the high
payroll
taxes required to finance the social insurance system, but also to excessive regulation of the
hiring and firing process under the Law on Employment and Unemployment Insurance and
the
Labor Relations Law. These regulations contribute to high labor costs and likely impede
private
market development. To promote greater flexibility in the labor market, the government
revised
both laws in 1997. During 1998-99, it will further amend the Labor Relations Law in order
to
reduce cash benefits by encouraging shorter maternity leave, ease restrictions and simplify
processes for terminating workers, and improve the flexibility of collective bargaining to
reduce
rigidity in wage-setting.The changes will allow private labor markets to
operate
with minimum necessary regulations by the law.

46. Previous amendments to the Law on Employment and Unemployment Insurance
strengthened work incentives by reducing the amount and duration of benefits for some
unemployed persons, in particular lowering the replacement rate from 50 to 40 percent for
those
who receive benefits for more than 12 months. They also reduced the role of the
Employment
Bureau and the state in matching workers to jobs. However, individuals with more than 25
years
of service can still receive unemployment benefits until retirement. The government intends
to
amend the Employment Law further in 1998 to reduce the special benefits for long-tenured
workers and to prevent employers from receiving unused benefits of newly-hired workers.
These
reforms are being supported by the World Bank's SSAC. In the future, the government will
also
review mandatory vacation leave, sick pay, and maternity benefits which are very generous
by
other countries’ standards and which significantly add to employment costs.

47. With the on-going support of the World Bank Social Reform and Technical Assistance
Project, the government is implementing several active labor market measures to tackle the
problem of structural unemployment and help those unemployed as a result of enterprise
restructuring to re-enter the labor force. These include: promoting a more extensive
market-driven program for training and re-training of workers, offering small business
development services and incubators, and promoting community-based economic
development
initiatives.

D. Education

48. The education system requires modernization if it is to cater to the needs of a
market-based
economy. At present, the wage bill in the education sector consumes an excessively large
share
of available resources and leaves little room for expenditure on materials and investment
and
maintenance of schools. While average student/teacher ratios for both primary and
secondary
education are close to OECD levels, there are a large number of overly-specialized
secondary
programs and a high ratio of non-teaching to teaching staff. The government plans to
address
some of the problems of the education sector through preparation of an education sector
strategy.
The World Bank and several bilateral donors are providing support to help re-orient
educational
programs, provide textbooks and materials, improve teaching skills, upgrade management
skills,
evaluate programs, and upgrade the infrastructure.

E. Health

49. The publicly-funded universal health care system has come under considerable financial
stress in recent years. The Health Insurance Fund (HIF) has been unable to exercise effective
expenditure control such that the quality of health care has declined and large arrears to
suppliers
have accumulated. The generous eligibility and benefit provisions of the HIF add to pressure
on
expenditures: the benefit package includes virtually all types and levels of care; large
categories
of individuals are exempt from co-payments; and co-payment rates are not set at levels
sufficient
to reduce over-consumption and promote lower cost primary care.

50. Health reforms envisaged for 1997 were stymied by organizational changes in the
government. To restore financial balance to the health system and improve the quality of
care, a
Health Insurance Law will be adopted in 1998 which will, inter alia: (i) establish an
autonomous
Health Insurance Fund governed by a representative board; (ii) establish a framework for
introducing a capitated primary health care system, a basic benefits package, revised
co-payment
user charges policy for health services, and a referral system by primary care providers for
outpatient specialist and hospital care; and (iii) reduce sick pay costs for employers. A new
Drug
Law will also be adopted which will allow for streamlined registration of drugs,
implementation
of reference pricing based on generic products, adoption of essential drugs lists for public
sector
reimbursement, and competitive bidding procedures for public sector drug procurement.
The
government’s reform efforts are being supported by the World Bank’s ongoing
Health Sector Transition Project and the SSAC.

51. The government is grateful for the substantial and useful technical assistance that has
been
provided in the last few years. Further external technical support will be needed to deepen
structural reforms and flesh out the detailed implementation of many of the envisaged
measures.
To this end, the government has prepared an updated report indicating specific technical
assistance requirements for 1998–99. Financing for technical assistance is being
sought
from the donor community.

52. The last bilateral agreement under the July 1995 Paris Club rescheduling agreement was
signed in January 1998. Agreement with London Club creditors on the rescheduling of
outstanding commercial debt inherited from the former Socialist Federal Republic of
Yugoslavia
was reached in 1997.

53. The recent devaluation of the denar, together with a stable macroeconomy and the strong
structural reform program supported by the ESAF arrangement, should provide for a
reduction in
the current account deficit in 1998 and over the medium term. Export growth is projected to
remain strong as the export sector shifts away from the reliance on traditional markets to
new
opportunities arising from increased trade integration in the Balkan region and with the
European
Union. Hence, despite strong import growth due to large capital spending in the transport
and
industrial sectors, the current account deficit is projected to decline from 8.3 percent of GDP
in
1997 to about 6.5 percent of GDP in the year 2000.

54. To meet the programmed increase in reserve cover to three months of merchandise
imports,
the external financing requirements for 1998–2000 are estimated at US$1.3 billion
(Table 4). Most of the financing needs are expected to be met
by
direct investment, commercial bank
borrowing, and other private inflows (US$606 million), official transfers and grants (US$72
million), and disbursements from multilateral institutions and bilateral creditors (US$496
million). While privatization receipts could fill much of the residual financing needs
(US$130
million), in view of the uncertainties the government is requesting further commitments of
bilateral support.

55. The external debt burden is large but not excessive. In 1997, medium- and long-term
external
debt amounted to US$1.1 billion (34 percent of GDP) and total debt service was US$127
million,
or 9.6 percent of exports of goods and services and 3.8 percent of GDP. The country will
continue to limit the amount of new debt that it contracts or guarantees on non-concessional
terms under the ESAF-supported program. By 2007, external debt is projected to decline to
17
percent of GDP and the debt service ratio to 5 percent of exports.